This paper uses stochastic simulation and my U.S. econometric model to
examine the optimal choice of monetary policy instruments. Are the
variances, covariances, and parameters in the model such as to favor
one instrument over the other, in particular the interest rate over the
money supply? The results for the regular version of the model provide
support for what seems to be the Fed's current choice of using the interest
rate as its primary instrument. On the other hand, the results support the
use of the money supply as the primary instrument if there are rational
expectations in the bond market.

Comments

This paper is an application of stochastic simulation to analyze
the optimal choice of monetary policy instruments. It uses
two versions of the US model
for the results, and it is an extension of the analysis in
William Poole, "Optimal Choice of Monetary Policy Instruemnts in a
Simple Stochastic Macro Model," Quarterly Journal of Economics,
1970, 84, 197-216, which was based on the IS-LM model.
The material in
Chapter 10, Section 10.4, and Chapter 11, Section 11.5, in
1994#2 is based on this paper.